Perpetual inventory system is one of the two basic ways to process the flow of information about purchases and sales. It is a system to keep continual track of additions or deletions in materials, work in process, and cost of goods sold on a day to day basis. Physical inventory counts are usually taken at least once a year in order to check on the validity of book records. Cost of goods sold therefore is kept on a day-to-day basis rather than being determined periodically. The other way is known as periodic accounting system.
When utilising perpetual, each purchase and sale transaction has a two-step entry. Sales entries directly affect the cost of goods sold account. Assuming that merchandise costing $450 was purchased, and one half of that merchandise was sold for $400, the necessary entries are shown as diagram.
If the merchandise is sold for cash, then cash would be debited. If instead, a promise to pay later was made, accounts or notes receivable would be debited. In addition, there an entry is needed to adjust both inventory and cost of goods sold. Under this method, inventory should always be determinable by looking in the records. Even when using this method, a physical inventory should be taken at least once each accounting cycle to assure the accuracy of the records.